Sunday, November 5, 2017

An Interesting Month - A Return to Normalcy?

October Class and Component prices were announced on November 1. It was a good month for producers with a 2% increase in the Class III price. Why was the Class III price up? The price of cheese was up and there is a tight correlation to the Class III price.

The analytics do indicate a return to more normal pricing. Milk protein took a huge jump up 24.3%. The milk protein price increase was the result of the two factors, cheese was up and butter was down (For more on the relationship see the October 22 post to this blog).

Chart I - Dashboard of Price Changes

This has brought the pie chart of component values making up the Class III price to a more "normal" relationship (Chart II). Milk protein's share of the Class III price increased from 31% in the prior month to 38% in October. Butterfat fell from 61% of the value in the prior month to 56% in October.

Cheese and butter prices are shown in Chart III below. While the butter price remains well above the price of cheese, there appears to be a move of falling butter prices and rising cheese prices. Chart III analytics plot the cheese and butter values over the last 18 years. Traditionally cheese and butter prices were pretty closely aligned. However, in the last three years butter prices have far exceeded cheese prices. The lower cheese price has kept the Class III price down and the high butter price has made butterfat more valuable than milk protein. If the trend of lower butter prices and higher cheese prices continue, there will be a higher Class III price with a split of component contributions (Chart II), favoring more value for milk protein and less value for butterfat.

Will the value move from butterfat to milk protein continue? Of course, this is impossible to predict, which is the reason to concentrate on increased components, both milk protein and butterfat, and not to try to change nutritional feed formulations back and forth emphasizing one component or the other. See more on this in the prior post.

Chart III - Wholesale Prices of Cheese and Butter

Again referencing the prior post, a producer practice of chasing the changes in milk protein and butter values by changing the nutritional parameters of feed is not a good practice. The goal should be to increase the level of both milk protein and butterfat in milk components.

Why are cheese prices rebounding? Domestic inventories of cheese are falling as shown in Chart IV below. Changes in domestic consumption always follow a consistent and predictable increase and do not cause inventory fluctuations. The fluctuations in cheese inventories result from changes in exports and cheese production.

Chart IV - Domestic Cheese Inventories

Excess milk production going to cheese has contributed to the 2017 high cheese inventories. As shown in Chart V below, cheese production is currently following a pattern of higher production compared to prior years, but at a much lower level than prior months. The level of production for July and August match the long-term increases in domestic cheese consumption. In March through June of 2017, the increases in cheese production were well above the levels needed to satisfy domestic consumption. Therefore, with weak cheese exports, inventories grew.

Chart V - Cheese Production by Month

Export of cheese for September will be covered in more detail in the next post to this blog, but the data is indicating a significant increase in September cheese exports.

The combination of lower cheese production and increased cheese exports are both contributing to the lower domestic cheese inventory. If these trends continue, inventories will continue to decline and the cheese price will increase. That will also increase the Class III price.

Butter prices fell 6.2%. Inventories (Chart VI) are following seasonal patterns. However, the butter inventory is at a slightly higher level in September compared to prior years. As the inventories go up, prices will fall. During April, May, and June of this year, inventories were below the levels of both 2015 and 2016. In July, August, and September the inventories were well above 2015 and just slightly under 2016 levels. As a result, the price of butter is falling. There is no current reliable data on domestic consumption, but new data will probably show a dip in domestic consumption with the high retail butter prices. Lower domestic consumption will lower inventories.

Exports of butter have been near zero for many months. In the next post both exports and imports of butter will be analyzed.

Chart VI - Domestic Butter Inventories

Butter production (Chart VII) trends are still following traditional levels in spite of higher consumption rates. The lack of additional domestic butter churning is an indication that companies have not added additional churning capacity because they are not certain that higher consumption will continue. The current low Nonfat Dry Milk /Skimmed Milk Powder (NDM/SMP) prices also play a part in the uncertainty of profits from adding new churning capacity. Skimmed milk for NDM/SMP production is the co-product of butter churning and impacts the overall profitability of butter churning.

Chart VII - Butter Production

NDM/SMP inventories are reaching extreme levels. NDM/SMP is primarily an export item. The export market is currently very difficult with stiff competition. Prices were down again in October. With the strong global demand for butter on the international markets, there is excess NDM/SMP available.

Chart VIII - NDM/SMP Inventories

The lower price for NDM/SMP raises additional concerns for Class I milk prices if the proposal for changing the skimmed Class I price formula is approved. The Class IV skimmed milk price is set solely by the price of NDM. A lower NDM price will lower the Class IV price and in turn, by the proposed change, would lower the skimmed Class I milk price. Currently the skimmed Class I price is based on the higher of the Class III or Class IV skimmed price. The proposal would use a simple average of the two Classes plus $.74/cwt. to calculate the Class I price.

In summary, October milk prices were positive driven by an increase in cheese prices. The future trends will continue to be followed in future posts to this blog.